Divdend Stocks: 3 Safe Bets and 3 Adventurous Plays

by Susan J. Aluise | May 2, 2013 7:00 am

[1]With the bull market running on fumes and bond yields lagging, investors are seeking dividends to ensure income and bank some of their recent gains.

The problem is, many “Old Reliable” dividend stocks like utilities are trading at premium valuations[2], while double-digit yields from more adventurous plays like dry bulk shippers and mortgage REITs might not be sustainable.

Unfortunately, if you want yield, you’re stuck with these options. So what you do from here is just a matter of risk tolerance.

If you’re a conservative investor, you’ll want to stick with “Old Reliable” stocks, but take heart — there’s still some decent yields to be had, even if they’re a little frothy.

But if you’re searching for dividend yields greater than 5%, you’re probably going to need to wade into the deeper end of the pool. Companies with those kinds of yields are usually in sectors that have fallen on hard times (like shipping) or investments that are inherently more volatile, like mREITs. These riskier plays may not be the best bet for income investors at or nearing retirement, but they’re not necessarily bad for everyone.

Here’s a look at three possible winners on both the safe and adventurous sides of the coin:

Safe: American Electric Power

[3]Dividend Yield: 3.9%

For the past couple years, American Electric Power (NYSE:AEP[4]) has battled headwinds including deregulation in Ohio and increased plant costs and environmental regulations. Industrial demand also remains soft in its area — a factor in last week’s first-quarter earnings miss[5].

But the utility, which provides service in 11 states, reported growth in residential and commercial power demand. And with rising natural gas prices, AEP is looking to coal for generation.

The stock looks overvalued based on a price/earnings-to-growth (PEG) ratio of 4.4 and a forward P/E of 15.5; it also hit a new all-time high last week. However, AEP increased its dividend last week, too — for a current yield of 3.88% — and has reliably paid its quarterly dividend for more than a century.

Adventurous: Diana Containerships

[6]Dividend Yield: 21.6%

If you’re in the market for high adventure, look no further than the high seas. Shipping companies have been tempest-tossed in the past couple of years. Diana Containerships (NASDAQ:DCIX[7]), which leases container vessels, has managed to pick up some sweet deals as new ships entering service, low freight rates and weaker economic growth have created rough sailing for the sector.

The first thing you notice about Diana Containerships is its white-hot current dividend yield of 21.5%. But while the company’s recent sale of its Maersk Madrid Panamax ship for scrap netted $8.8 million to help cover the dividend, weak freight markets forced the company to dispose of that asset prematurely. Also, the company’s year-over-year EPS is expected to decline nearly 80% as existing sale/lease back charter rates expire.

I consider DCIX to be a “mad money” stock for investors who believe a 30-month trend of laggardly dry bulk shipping rates is bound to turn around at some point.

But caveat emptor: This sky-high yield is anything but safe.

Safe: Waste Management

[8]Dividend Yield: 3.6%

Face it: In good times or bad, garbage is big business, and Waste Management (NYSE:WM[9]) is going the extra mile to deliver for shareholders. Last week, the company reported first-quarter earnings[10] that missed analysts’ EPS estimates by a penny, but restructuring charges were part of that miss.

The company’s restructuring efforts — combined with cost efficiencies and rate hikes where contracts allow — will position Waste Management for future gains, particularly if the churn rate continues to trend lower. The company’s recycling business, as well as its waste-to-energy initiatives, could provide the company with longer-term growth opportunities.

WM’s 16.9 forward P/E and 2.48 PEG are frothy, and like AEP, it’s also trading at all-time highs. But again, WM is a reliable dividend payer, and its yield is an attractive 3.6%.

Adventurous: Annaly Capital Management

[11]Dividend Yield: 11.4%

Mortgage real estate investment trusts posted eye-popping returns last year as they cashed in on ultra-low mortgage rates and passed those wide interest rate spreads onto investors in the form of double-digit dividends.

As one of the leaders of the pack, Annaly Capital Management (NYSE:NLY[12]) boasts a whopping 11.5% yield, and it’s trading at just 11 times next year’s earnings, which isn’t too out of line with the rest of the sector.

Nevertheless, potential investors should consider a couple of factors before they ante up. Mortgage rate spreads likely will be tighter this year than they were last year. Regulators and lawmakers recently have cast a critical eye in the direction of mREITs — a sign that NLY and its peers might face curbs on borrowing or see less favorable tax treatment. These factors could potentially bring that lofty yield down to earth.

Safe: Dominion Resources

[13]Dividend Yield: 3.7%

Last week, Dominion Resources (NYSE:D[14]) reported flat first-quarter earnings, largely on lower electricity demand, higher costs of restoring power after storm outages and a delayed opening of its new natural gas processing facility in West Virginia.

Nevertheless, Dominion is optimistic that its new focus on processing shale gas in its region — combined with its exit from coal processing — will give it a winning edge moving forward.

The stock is trading at all-time highs, and naturally is expensive on PEG and forward P/E fronts (2.49 and 17.2, respectively). However, Dominion has been increasing dividends for six years and has reliably paid out quarterly for decades.

Adventurous: Windstream

[15]Dividend Yield: 11.8%

Windstream (NASDAQ:WIN[16]) is staking its claim on the bleeding edge of the telecom marketplace, but this advanced communications and cloud computing service provider still provides traditional phone service to 638,000 businesses and 1.8 million consumers nationwide. WIN also provides high-speed Internet and digital television services.

WIN offers a current dividend yield of 11.8%, and has consistently paid a dividend since 2006. However, its negative PEG ratio points to challenging near-term earnings, and its forward P/E of nearly 17 is pricey in a sector where even AT&T (NYSE:T[17]) is trading at just 14 times forward earnings. In this highly competitive market, quality of service will be a differentiator.

On Tuesday, the company’s phone network experienced a multi-state outage that lasted more than five hours, and while all service providers experience outages, perception is hard-won in the enterprise market. WIN has upside, but I wouldn’t take that thick yield to the bank just yet.

As of this writing, Susan J. Aluise did not hold a position in any of the aforementioned stocks.